February 18, 2015

GDP: A Brief but Affectionate History

Diane Coyle’s recent book[2] has been on my reading list for some time, making it to the top of the pile over the Christmas break. Working at the IMF, and even just taking an interest in the Business and Economy pages of the media, the notion of GDP looms large. We take the concept of GDP for granted, but I have never been entirely comfortable with the way GDP figures are bandied about to compare the economic performance of disparate societies or to justify this or that unpopular policy; a good historical perspective on where it comes from and what it means seems like just the thing to assuage these misgivings.

Ms. Coyle gets down to business right from the first lines in her introduction. She opens with the still-topical challenges faced by the head of the Greek statistical agency (an ex-IMF staffer) in 2010 to highlight the significance of GDP in modern politics and finance, also acknowledging the various conceptual challenges that it faces.

Moving on, the book presents a fascinating discussion of the meandering development of national accounts statistics and the forerunners of GDP that, even in the early stages, were subject to a debate about whether the goal was to measure economic activity (as a means to estimate the potential for taxation and wartime productivity) or to evaluate a more humanistic concept of ‘welfare’. It quickly becomes clear that GDP is not a natural phenomenon like annual rainfall or land mass, but an artificial construct, and an extremely complex one at that, subject to considerable algebraic manipulation and seemingly arbitrary rules.

From this perspective (it seems to me), using GDP as an indicator of a country’s economic health is analogous to a doctor collecting all one’s vital signs—blood pressure, strength, cholesterol level, white blood cell count, and so on—and aggregating them through a spreadsheet to tell you how healthy you are. Then, periodically repeating the exercise to see if you are more or less healthy than before. And, finally, comparing your overall health indicator with someone else who might be living in a completely different environment to arrive at a judgment about which person is the more healthy.

In addition to its clumsiness as an indicator of economic activity, there is a tendency for observers to conflate GDP with wealth or poverty. This is a trap into which Ms. Coyle falls when discussing whether Africa is ‘poor’ on the basis of its GDP. Her point is that African countries’ GDP is seriously understated. From my viewpoint as an accountant, however, wealth is not the same as income or production, but reflects the value of a country’s net assets. Countries that report low GDP can be very wealthy in terms of natural endowments. The issue is not one of wealth but of productivity in seizing the economic potential of the assets. This suggests that the response to well-endowed but low-output countries should not be the transfer of more wealth but to increase their productive potential.

As Ms. Coyle takes us through GDP’s interesting history, she pulls no punches in acknowledging methodological challenges: government services with no private sector analogue are valued at cost rather than the value of their output so any productivity gains will never be evident; consumption of vast amounts of cheap, imported novelties adds to GDP and landfill in equal measure; intangible non-physical productivity is difficult to capture, an egregious weakness given the perceived significance of financial services in many countries; voluntary or own-account production (e.g. domestic housework) is generally not counted; there is no means to account for quality differences to recognize, say, innovation or variety; and so on. The conclusion is that GDP information is subject to a large margin of uncertainty and does not measure either a nation’s well-being or its balance sheet. These are legitimate concerns given all the attention paid to this rather arcane statistic.

The point that GDP does not measure social welfare has been a subject for debate since the early days of national accounts and is revisited periodically throughout the book. The alternative approach embodied in, say, the United Nations’ Human Development Indicator with its emphasis on human capabilities and inclusion of social welfare-related issues (such as life expectancy, rule of law, child mortality, access to education, modern utilities, liberty and freedom, health and development) is discussed. Subsequent chapters raise the conceptual and practical issues relating to the measurement of ‘happiness’, introducing other alternative indices, including: the Measure of Economic Welfare; the Index of Sustainable Economic Welfare/Genuine Progress Indicator; and Net National Product (which seems particularly appealing for its recognition of the importance of innovation and the effect of running down non-renewable assets). Another issue that has received a lot of recent attention is the distribution of the gains from GDP growth.

A key lesson learned from all this work is that more balanced public policy decisions could be informed by a dashboard of individually significant, complementary indicators (akin to considering blood pressure separately from blood sugar levels and other indicators of human health) rather than using the present unitary GDP statistic as a kind of global proxy. This seems an eminently sensible approach, but has yet to gain much traction.

Ms. Coyle’s engaging, accessible, almost equation-free book certainly lives up to the promise of its title and provides much food for thought besides (although I have trouble digesting her assertion (page 96) that the purpose of business is not maximization of profit or shareholder value). Despite articulating the many weaknesses of GDP and the way it is used, and despite presenting a good case for looking at alternatives, she concludes that we should not be in a rush to ditch GDP. She is certainly not alone in this view. For example, it seems to be the conclusion reached by the BBC’s Chief Business Correspondent in a 2014 piece called “Is GDP the Least Worst Alternative?”[3]

Nevertheless, Ms. Coyle goes on to propose three issues for deeper consideration in order to redefine our understanding of what ‘the economy’ is, and to develop a more meaningful construct than GDP currently provides. These three issues are: (i) the increasing complexity of the global economy and its interdependent supply chains; (ii) the growing importance of intangible outputs; and (iii) the urgent issue of sustainability to link economic growth to the associated costs in terms of depletion and degradation of assets.

Hopefully, there will be no shortage of heavy-weight economic thinkers ready to take up this important challenge.

Note: The posts on the IMF PFM Blog should not be reported as representing the views of the IMF. The views expressed are those of the authors and do not necessarily represent those of the IMF or IMF policy.

Comments

To my mind the question is the emphasis on GDP growth and the disconnect between it and the lessons of the Easterlin paradox. Also, as we see from the example of recently industrializing countries, what price GDP growth, however measured? As you rightly say, wealth is not the same as income or production and unless we see the intangible costs and factor them in we shall make mistakes of eulogizing GDP growth while ignoring the ancillary damage to health and environment it creates but still does not bring happiness (but a larger TV or car- yes!)